March 5, 2012

Team Romney Rallies Around Carried Interest

It has been apparent for a while now that Mitt Romney’s candidacy is less than ideal for the one percent, or the one-tenth or one-hundredth of the one percent. It is one thing to have a candidate who is committed to promoting unjust tax policies that will help you and your fellow millionaires; it is another thing to have a candidate who benefits from those unjust policies, thus making himself a poster child for reform. Romney pays a federal income tax rate of only 14 percent on his income of more than $20 million per year because of two features of the tax code. First, capital gains on investments, the bulk of his income, are taxed at only 15 percent, well below the top marginal rate of 35 percent for ordinary income. Second, the income he still collects from Bain Capital, as part of his retirement deal there, is eligible for the carried-interest loophole, which allows fund managers to have their compensation for investing other people's money taxed as capital gains, not earned income.

The carried-interest loophole, aka the hedge fund loophole, has been hanging on for dear life for a while now, protected by Wall Street friends like Eric Cantor, who has raised more from the securities and real estate industry than any congressman in recent years, and fought to keep the loophole off the table in last year’s debt ceiling showdown. But fewer and fewer people are willing to defend it. Pete Peterson, who benefited hugely from the loophole while running Blackstone, has come out for closing it, and I was stunned, in the days after Romney’s tax rate became an issue, to see even Stephen Moore, the Wall Street Journal’s ardent supply-sider, admit on TV that it was time for the loophole to go.

But lo and behold, what did I see tucked inside the business section of Sunday’s New York Times but an earnest effort to justify the loophole penned by Harvard economist Greg Mankiw. Mankiw is a veteran of George W. Bush’s administration. He is also one of the lead economic advisers to...Mitt Romney. And writing in the Times, he did an impressive job of muddying the water around a question that truly is as as clear-cut as they come: why should investment managers have the compensation for their labor taxed at a far lower rate than all other professionals? You’ll have to read it to believe it, but Mankiw’s trick is to bring in the more sympathetic example of a carpenter who teams up with an investor on a real estate project that turns a profit. Under current law, the carpenter’s share of the profits are taxed as capital gains, just as the investor’s are, even though in the carpenter’s case what he was putting into the project was his sweat equity, not an investment stake. If the carried interest loophole were closed, notes Mankiw, the carpenter would be taxed at a far higher rate than the investor he teamed up with. Well, yes—but that's only because we tax capital gains at a much lower rate than ordinary income. If Mankiw is so bothered by the carpenter’s fate after the closing of the carried interest loophole, then he should be pushing for the equalization of the tax rate for investments and earned income.

For now, though, it is clear that all the investment managers out there can rest easy: it looks like Team Romney will not let his personal stake in the matter keep it from arguing vociferously for maintaining the carried-interest loophole. And for the rest of us, it looks like we better get ready for many comparisons of the plight of Mitt Romney and other multi-millionaire money managers to the plight of a humble carpenter. Next thing you know, Romney might start putting nails in his mouth and spitting them out, pointy end forward.

*Update at 11 a.m.: Well, it looks like Mankiw’s defense of carried interest is even more eye-opening than I realized: Matt O'Brien, a former TNR intern now at the Atlantic, notes that Mankiw came out for closing the loophole back in 2007, when he used a rather different analogy in writing on his blog:

Deferred compensation, even risky compensation, is still compensation, and it should be taxed as such. Paul Krugman hit the nail on the head with this question: ‘why does Henry Kravis pay a lower tax rate on his management fees than I pay on my book royalties?’

The analogy is a good one. In both cases, a person (investment manager, author) is putting in effort today for a risky return at some point in the future. The tax treatment should be the same in the two cases.

What to make of this? O’Brien, tweeting @ObsoleteDogma, suggests: “Whole point of the NYT piece was obfuscation. I’m not sure Mankiw has changed his mind. He’s just not saying now.” Or who knows: maybe, like Rick Santorum, Mankiw is just getting ready to “take one for the team.”